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The following is a reply to a discussion started with Behind My Screen over on this thread about term limits for the President (you'll have to read to see how we got from that to personal accounts for Social Security). Since I thnk this would be the more appropiate place to have this discussion...here goes.
Behind My Screen writes:
Moving from defined benefit to defined contribution means that you are not protected against LOSING MONEY. that would mean there is no security. Lets also not forget that Social security is NOT a retirement benefit, it is an insurance. It is there to insure that workers will have something when they retire, or become disabled... it is also there to insure that a worker's children continue to get support in the event that the worker dies while his children are below he age of majority.
A private system will not in any way make the system better... it will drop all benefits for children and have very little money to support a worker who becomes disabled at 30.
sure.. you MIGHT make more money for retirement, but I think the enron fiasco and all the other Corporate fall-outs that sent retired folk back to work because they lost EVERYTHING proves that such a system could not provide security to everyone and would rather just provide lots of money to wall street investment houses who handle the transactions.
Social Security is a Ponzi Scheme. It relies on taking a little from many and giving it to a few. The problem is that we are heading into a period where there will be more people taking from the system than
their will be putting money in. Take a look:
- In 1950, there were 16 workers to support every one beneficiary of Social Security.
- Today, there are only 3.3 workers supporting every Social Security beneficiary.
- By the time today's youngest workers turn 65, there will only be 2 workers supporting each beneficiary.
(Source: WhiteHouse.gov)
Social Security has been presented as a retirement plan. It isn't because a real retirement plan saves money. A real retirement plan lets money sit and grow till it is needed. Social Security takes money from
you and gives it too someone else. What money that is left over is then used on other government programs. Instead of having an account that is in value you have collection of IOU's.
Social Security has been presented as insurance. It isn't. Insurance is a bet between you and the insurance company on something happening. You pay a premium to the insurance company as a hedge against something costly happening (car accident, health problem, whatever). The insurance company takes the premiums, uses them to pay off claims, save and invest the rest to make a profit. A well run insurance company will always be able to pay its claims because it brings in more than they will have to pay out. Social Security though will not be able to because it will be paying out more than it can bring in.
What is Social Security insurance against? I suppose the best answer is income loss due to advanced age. Ok, well insurance funtions to make you whole when or if the event happens. If my car is in a wreck they pay to repair it or the replacement value. If I get sick or injured health insurance pays for my medical bill. So, how does Social Security insure me against an income lost? Does it continue to me my salary when I retire? Let us say I'm making $50,000 a year have been quite accustomed to that $4166 montly paycheck. What can I expect monthly from the insurance policy known as Social Security? $1,302 per month. I would say that probably makes Social Security the worse insurance policy in the world. Of course what would you expect from a government run insurance program (then you wonder why I don't want the government running healt care - they can't handle my money right, why do I want to put my health in their hands). Tell you what, let me have my Social Security money. I promise to put it in 5 year CDs till I retire and when I do I promise not take any money from someone paying into Social Security. Please?
It really comes down too is that a retirement or insurance plan guarantees that they can be paid out because the money paid in belongs to you. Social Security has no such guarantee. There is nothing in the Social Security program that requires they give you that money back. When they start running out of that money - wanna bet that they're will be some who don't get what they've paid in. Pehaps that someone will be you.
A big objection to privatizing Social Security is that you run the risk of losing money. I would argue that you are losing money with the current Social Security program. The average rate of return that you can expect with Social Security is 1.23%. That is only .23% better than the APY of a savings account at my credit union. The I-bond is a government bond is designed to protect you against inflation currently pays 2.41%. The money market accounts at my credit union pays 3.55%, with options of going up to 5.05% as you get more money in there. Of course though the money market account at my brokerage (which is really designed to be a holding place while I shift money between investments) pays over 4%. A number of banks offer no minimum balance saving accounts above 5%. Five year Certificate of Deposits pay up to 5.75%. Let us not forget that the average rate of retun from the stock market is 11%. While there is a risk of losing money in a private account, it is guaranteed you lose money under the current Social Security program.
The thing that scares most people is that somebody will lose their Social Security money due to a scandal like Enron. Personally, I do not believe the government should be involved in protecting people from their own stupidity. Of course, as a technical point I don't believe government should be involved in making people save for their retirement either. Since however the government is putting a gun to your head and taking some of your money to put into an account for you to draw upon later then I suppose the government should take some responsibility in making sure you do so wisely. Ideally the government would only provide education on how you should invest your money to prepare for the future. It would then be up to you to follow said advice or not. However, since I just know some people would want to do stupid things with there money I would limit what they could do. You would not be allowed to buy stock in individual companies. You would only be allowed to buy mutual funds that have proven track records. Preferably index funds but I would allow actively managed funds that meet strict criteria for those who would like a little more risk in your profile. Through the power of dollar cost averaging and compound interest protected by time and diversification you will make money. The fact is that you can not find a 40+ year period where you would lose money with a well diversified portfolio in the stock market.
Putting money in the stock market is what any financial advisor would tell you to do particularly to save for retirement. It is true. Any financial advisor worth their salt will tell you to do the following to prepare for retirement. First, start saving money in a tax advantaged account like a 401k or an IRA. Second, invest the money in that account in a mixture of stocks and bonds appropiate to your time horizon to retirement. Third keep saving and investing money till you retire. Save, invest, repeat. Here is another morsel for your consideration. Companies like Vanguard and Fidelity have started what are known as lifecycle funds. In these retirement funds you put the money and the company invests them. They then automatically adjust the asset allocation over time for you. Do you know where they keep most of the money? The cycle starts by putting approximately 90% of your money in stock index funds and 10% in bond funds. Over time they adjust that so that when you retire your invested in 60% stock index funds and 40% bonds. By the way, for anyone interested in a primer on how to retire comfortably check out my article, How to Retire without Social Security (I know it is a cheap plug, but it really is good place to get started with preparing for your retirement).
Not everyone though is comfortable investing in the stock market. It isn't for everyone. That is ok - you can put the money in something safe like bonds, government bills, CD's or if you really, really want leave it in the current program. You can even have a balanced mixture of equities and bonds (which would of course be the smart thing to do). On average we are talking a difference in rate of return between approximately 1% and 10%. Its your choice. Under the current system - you have no choice and are stuck with a crappy 1.23% rate of return.
What happens to your Social Security money if you die? Do you think that the your money that you have been saving in your Social Security account goes to your survivors? Nope - they get a paltry death stipend and the rest goes to the government. Under a personal account plan your survivors would inherit your money.
We do not have too try and buy into the theorectical. We have real world examples. Galveston Texas took advantage of a loophole that allowed them to opt out of the Social Security program in 1979 (Congress closed this loophole in 1983). Making similar contributions to their Alternate Plan that are made into the Social Security plan Galveston has reaped the following:
- A person retiring today at age 65 with 40 years of deposits and an annual salary of $20,000 would retire with $383,032 in a personal
account. - Someone with a $30,000 salary for 40 years would retire with $573,782.
- And a person with a $50,000 salary for 40 years would retire with $956,303.
A personal retirement account this size provides a much larger post retirement income than does Social Security:
- A retired $20,000-per-year worker with the personal retirement
account would receive $2,740 each month at current interest rates,
while Social Security benefits would be about $775 per month. - A $50,000 per year worker would receive $6,843 per month from the private plan, compared to $1,302 from Social Security.
The citizens of Galveston also benefit from a greater disability and death benefit:
- The life insurance benefit is three times the worker's salary (with a minimum benefit of $50,000 and a maximum of $150,000); Social Security, by contrast, pays a one-time death benefit of $255 to a
surviving spouse. - Disability insurance under the Alternate Plan pays 60 percent of an individual's salary until age 65 or until the individual returns to work and is relatively easy to qualify for, while Social Security disability benefits can be very difficult to qualify for and are unavailable to young workers who have not yet worked the required amount of time.
Galveston is not the only place where retirees benefit from a privatized social security account. Chile is beginning to reap the benefits of private accounts. Since 1980 they have been contributing 10% into private account that have been receiving a annual rate of return of about 10% a year. Other countries around the world also have successful privatized systems.
Let us touch on the final problem with switching to personal accounts for Social Security. What happens to the people currently on Social Security or soon will be? Well the fact is we do have to pay out to them. They spent a lifetime paying into the system and deserve to get what the system promised them. Since there is only a bunch of IOU's in the Social Security account we cannot just switch 100% of everybodies contribution over to personal accounts though. We would have to shift people over to personal accounts in phases like the following (by the way aside from the first bullet point the rest of the numbers are guesses.....I'll leave to real econonmists to figure out how the shift really will have to happen):
- People currently receiving benefits would continue to do so.
- People within 5 years of receiving benefits would not be allowed to switch to personal accounts and would receive the benefits of the current system.
- People within 6 to 20 years would have the option of staying 100% with the current system or be allowed to put a portion of their contributions towards a personal account. When they retire they would draw benefits from both account appropiately based on what they have already contributed and future contributions.
- People within 20 to 50 years of receiving benefits. would pay the portion of their contributions needed to support the people on the current system. They would not receive a benefit from this portion. This is unfortunate but I suspect it will be necessary (well it wouldn't if the FairTax was passed but that is a different subject). The remainder of their contributions would go to a personal account which should still allow them to save enough to retire with a benefit greater than what they would receive under the current system. As people fall off the rolls of collecting from the current system the percentage of the money going to the personal account would increase
- People who enter the workforce at 50 years out would be contributing 100% into their own personal account.
The point of the matter is that those currently on and soon to be on Social Security would be guaranteed to receive 100% of their benefits. Contrary to the claims of the AARP this is not a senior citizens issue except to those seniors concearned about how their children and grandchildren will retire (which is why you should check out NASCON as an alternative to the AARP).
The fact is Social Security in its current form will go bankrupt. It will do this because 1 person is dependent on 3 people. Unfortunately 2 of those 3 are going to retire and there is no one to
replace them. Even if this fundamental flaw was not built into the system it simply is a poor system for saving money and building wealth. You would be better off if you took 12% of your paycheck, putting it into a standard savings account and leaving it there. Personal accounts shifts the system so that you are saving for yourself and your heirs. It allows you to safely invest that money with a risk tolerance that you are comfortable with. It gives you choice and independence. Personal accounts makes Social Security a retirement plan instead of a welfare program.
